What is a High-Yield CD, Anyway?


17 February,2014

We hear a lot about high-yield CDs, and trying to beat inflation in our current interest-rate climate. One of the difficulties associated with high-yield CDs is that they aren’t exactly “high-yield” in the way they were prior to the financial crisis and recession.

In fact, many of us who had CDs paying in excess of 5 percent back before the financial crisis find the current state of affairs rather disappointing. With interest rates so low, and likely to remain that way through the end of 2014 (and maybe 2015), the concept of “high-yield” has changed.

Comparing High-Yield CDs

This reality has many comparing CD yields and carefully trying to find the highest CD rates. Some CD rates are as high as 1.20 percent, if you are willing to get a three-year CD. You can do even better if you are willing to get a longer-term CD. You can get up to 2.50 percent with a five-year CD. However, to get that high of rate, you often need a higher deposit. Some of the best deals involved a minimum deposit of $500 to get a 2 percent rate for five years. If you go with a CD that doesn’t require a minimum, you will be lucky to get a five-year CD with a rate above 1.70 percent.

Comparatively speaking, this is a very difficult situation to be in. You might want the safety associated with FDIC-insured (or NCUA-insured) CDs, but it’s hard to build wealth with such low rates. In fact, the rate environment right now means that you might not even be able to preserve your capital, since your spending power can be eroded by inflation.

The average inflation rate in 2013 was 1.5 percent. That means that, last year, you probably weren’t going to beat inflation by very much, unless you were willing to lock your money away for a long period of time — and if you had enough to beat the minimums. Sure, if you could get a CD with a 1.6 percent or 1.7 percent yield, you would have still beat inflation, but not by much. You’d just be able to preserve your capital.

However, to make that work, you would have had to lock in that rate for five years. So what happens if interest rates start rising and inflation picks up as the economy improves? The next two or three years could see inflation rates rise to 2.5 percent or 3 percent. You’ll still have a few years left on your CD, and now you’re losing money in real terms. The fact that you beat inflation for the first year or two with your CD doesn’t seem so great when you’re locked in and you have to watch rates rise without the ability to take advantage.

CD laddering can alleviate some of the frustration, but it’s still not going to be a strategy that helps you build long-term wealth. Instead, you might be better off looking for alternatives to CDs. There are other ways to build wealth over time, and now is a good time to look for them, since it’s unclear when truly “high-yield” CDs will make a comeback.